‘Taxmageddon’ looms at end of payroll tax holiday

With Congress voting last week to extend the payroll tax holiday, 160 million workers will be spared an immediate tax hike. But the move leaves them facing an even bigger hit in January, when the holiday ends and the payroll tax joins a long list of levies already set to sharply and abruptly go up.

On Dec. 31, the George W. Bush-era tax cuts are scheduled to expire, raising rates on investment income, estates and gifts, and earnings at all levels. Overnight, the marriage penalty for joint filers will spring back to life, the value of the child credit will drop from $1,000 to $500, and the rate everyone pays on the first $8,700 of wages will jump from 10 percent to 15 percent.

The Social Security payroll tax will pop back up to 6.2 percent from 4.2 percent under the deal approved Friday by Congress. And new Medicare taxes enacted as part of President Obama’s health-care initiative will for the first time strike high-income households.

The potential shock to the nation’s pocketbook is so enormous, congressional aides have dubbed it “Taxmageddon.” Some economists say it could push the fragile U.S. economy back into recession, particularly if automatic cuts to federal agencies, also set for January, are permitted to take effect.

Obama and congressional Republicans say they hope to avert the coming blow, which stands to suck roughly $500 billion out of the economy in 2013. But both sides are bracing for another epic showdown in the weeks after the November election, as Democrats prepare to use Taxmageddon to break the partisan impasse over taxes that has blocked action on an array of issues, from modernizing the nation’s infrastructure to taming the national debt.

“I see the framework of a big agreement in the lame-duck [congressional session] to finally put this divisiveness behind us,” said Rep. Richard E. Neal (D-Mass.), a senior member of the tax-writing House Ways and Means Committee. “Obama’s going to have great leverage to get something done.”

Since they took control of the House last year, congressional Republicans have needed nothing from Obama. They were the holdouts, demanding big cuts in federal spending in exchange for helping Obama keep the government open and raise the legal limit on government borrowing, known as the debt ceiling.

But in December, deadlock will cut the other way. Republicans need Obama if they want to prevent one of the biggest tax increases in U.S. history — nearly $5 trillion over the next decade, by official estimates — and block deep cuts to the Pentagon that could be triggered as part of last summer’s debt-ceiling accord.

The tax shock is set to occur after the Nov. 6 election but before the new Congress — and potentially a new president — take office two months later. While the outcome of the contest is likely to color the tax debate, Obama will either be freshly reelected or on his way out and, therefore, free to play hardball with Congress.

White House officials say Obama will not sign another full extension of the Bush tax cuts, as he did in December 2010. Obama is demanding a partial extension that would preserve the cuts for middle-class taxpayers but permit rates to rise on household income over $250,000.

“The president has made clear that he will veto any bill that extends the Bush-era tax rates for the wealthiest 2 percent of individuals,” White House spokeswoman Amy Brundage said. “We will continue to fight for tax relief for the middle class and those trying to get in it, while insisting on a policy that asks the wealthiest individuals to pay their fair share.”

Many Republicans and outside analysts say they doubt Obama would make good on his veto threat. Allowing all of the Bush tax cuts to expire would harm middle-class taxpayers, along with the wealthy, and carry grave risks for the economy.

“My forecast is that tax rates are not going to rise for everyone on January 1, 2013,” said Mark Zandi, chief economist for Moody’s Analytics, who predicted that Taxmageddon, combined with the cuts from the debt-ceiling deal, would slash economic growth by nearly three percentage points next year. “That would be pretty difficult for the economy to overcome.”

Still, Democratic spines may be stiffened by polls showing broad support for their latest tax strategy, which emphasizes higher taxes for millionaires rather than the merely well-off. A recent Washington Post-ABC News poll found that 72 percent of Americans support raising taxes on people with incomes over $1 million a year, in line with Obama’s call for a “Buffett Rule” that would require those families to pay an effective tax rate of at least 30 percent.

“The tax issue, for the first time in decades, has flipped so Democrats actually have the high ground,” said Sen. Charles E. Schumer (N.Y.), the No. 3 Senate Democrat and the man who came up with the idea of raising the income threshold. “Most Americans share our belief that, while the middle class should not pay an increase in taxes, the wealthiest among us should.”

He said Senate Democrats plan to press that advantage in the coming months, staging numerous votes on issues of tax “fairness.” Republican reluctance to target the rich is their “Achilles’ heel” politically, he said.

Schumer predicted that before November, Republicans would drop their opposition to tax increases for millionaires. “Politically, it’s going to be very harmful to say, ‘I’m not for something like the Buffett Rule, when even 60 percent of Republicans are for it,” he said.

Many Republicans maintain that they would never raise taxes on a group the GOP views as small-business owners and “job creators.” Besides, Republican strategists said, they are likely to have bargaining chips of their own in December.

For instance, without congressional action, nearly 30 million families will have to pay the alternative minimum tax, which adds thousands of dollars to the average tax bill, in April 2013. Congress typically protects those people through annual adjustments, and the latest “AMT patch” expired in December.

Another potential GOP tactical advantage: the debt ceiling. Treasury Secretary Timothy F. Geithner acknowledged in congressional testimony last week that Obama may need Congress to raise the legal limit on borrowing, now set at $16.4 trillion, before the end of the year.

“This idea that they hold all the cards? They don’t,” said a senior Republican Senate aide. “We’ve got more leverage than these crowing Democrats like to think.”

Then there’s the matter of the election itself. With control of both chambers of Congress and the White House all potentially in play Nov. 6, the voters could upend Democrats’ best-laid plans. If Republicans claim the White House and the Senate after an election waged in part over tax policy, demoralized Democrats might agree to extend all the Bush cuts without a fight.

“It depends on who’s president,” said Sen. Orrin G. Hatch (Utah), the senior Republican on the Senate Finance Committee. If Obama is reelected and Democrats hold the Senate, he said, “it makes it much more difficult” for Republicans to press for a full extension.

While some Republicans are ready to man the tax barricades, among others the GOP’s anti-tax orthodoxy is starting to crack. Forty Republicans in the House and 32 in the Senate have endorsed the concept of a grand bargain to tackle the national debt, which would require Republicans to raise taxes and Democrats to accept cuts in federal health and retirement benefits. With Obama continuing to call for a grand bargain, that group is working with Democrats behind the scenes to draft a plan able to win bipartisan support.

Meanwhile, House Armed Services Committee Chairman Howard “Buck” McKeon (R-Calif.) has said he would take higher taxes over defense cuts. And during unsuccessful debt-reduction talks last year, Sen. Patrick J. Toomey (R-Pa.), one of the Senate’s most ardent conservatives, drafted a plan that would have included $300 billion in new revenue over a decade.

“I think one of the reasons that you saw Pat Toomey offer what he did is a realization that we’re going to have a $5 trillion tax increase at the end of the year,” said Sen. Bob Corker (R-Tenn.). “Hopefully, this year we’ll actually do something constructive and work out something that’s sensible over the long haul.”